Are Chinese stocks in for a serious plunge?

Stock returns in 2011 have been nothing to write home about and especially European and Chinese investors have felt the pain as their respective stock markets are down 23.6 and 21.0 percent year-to-date in local currencies.

Chinese stocks fell another 0.3 per cent overnight after being down 2.6 percent in the first half session. The Shanghai Composite Index is now very close to levels seen when we all thought the Western banking system would collapse (see chart below).

Source: Bloomberg

Now the questions to be asked are:

Are European sovereigns defaulting and taking the Euro down the drain?

Is China’s property market and export-driven economy crashing?

Well Greece defaulted in our view and more countries are likely to go down that road as well. Whether it will break up the Euro is another story. In the meantime we believe EU leaders will adopt a new EU treaty providing a more flexible mandate for the European Central Bank to “help/monetise” on the debt burden. As we wrote last Friday, Europe’s stock market valuation is moving into a territory where most ought to be aggressive buyers for the long term.

China is a strange animal. It is like when scientists find new species; we find them colourful and exciting but we do not know much about them. The same goes for China. Data about exports and inbound containers in the U.S. and Europe clearly shows that exports out of China have slowed down. Other data also shows that property prices in China are coming down in all segments except for the expensive high-end market. Given China’s economic composition these factors are for sure a terrible cocktail.

Given the recent decline in Chinese stocks and with data pointing to an economic slowdown it sure looks like more pain could persist. But with the Shanghai Composite Index trading at 11.7x P/E it is getting more temping to have some Chinese exposure.